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This article on cnn.com paints a nice path toward the eventual deployment of handheld AR games. Right now, they are not doing AR, just geolocated content, but by focusing on devices and concepts that require magnetic compasses in the phones, they will hopefully help push manufacturers toward creating devices with full 3d orientation sensors. Again, as the article points out, we need both position (good GPS, better than currently available), a good compass AND tilt/roll sensing (full 3D orientation) to know “where you are looking.”

Eventually, 3D position and orientation like this will just be the starting point, and the devices will use other information in the world (models of buildings, such as this system demonstrates, or the imaged-based approaches being worked on by Nokia Palo Alto researchers). When such systems (which will require a massive amount of information about the real world, much more significant that systems like Google Earth and Google Streetview) are deployed, we can finally start doing REAL AR in the physical world.

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Some day not long me thinks.
Theres going to be a tiping point, then it will be an arms race. (probably either by mobil phone or game companys)

I think the Model-based Tracking link showcase’s a good path forward, particularly if data is collected on mass to create such models (or at least, key-points) Microsofts Photosyth technology could well lead to a very large collection of landmarks around the earth automaticaly modeled in 3d from photos.

full angle sensing is now a low cheaper thanks to Nintendo pushing down the prices. (or at least, will be, when the millions or so orders of the small gyros needed for the wiimote upgrade go though).

And better GPS will be coming as soon as europe gets its act together with Gallio (accurate down to the meter for cilivian use).

Its only the output devices that are really lagging behind, imho.
Companys are still scared to go near anything remotely like VR headsets, even optical see-though or eye projection. (both very possible with todays technologys if they were invested into).

At the moment AR is either where a massive bulky custom headset (video-see-though), or lose the use of your arms.